Are Self-Dealing Parties Settling $242 Billion of Bank of America Liabilities for Way Too Little?

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A petition filed by some unhappy investors on Tuesday raises some serious challenges to the so-called Bank of America mortgage settlement. The embattled bank hopes to shed liability for alleged misrepresentations made by Countrywide on loans sold in 530 mortgage trusts with $424 billion in par value. We said it was a bad deal for investors because, among other things, it included a very broad waiver of a very valuable right, that of being able to sue over so-called chain of title issues (in very crude terms, whether the parties to the deal did all the things they promised to do to convey the loans properly to the mortgage trust).

This action raises three sets of different issues: the conflicts of interest among the parties trying to push this deal through, the process used to finalize the deal, which this pleading contends were devised to give the other investors short shrift; and the inadequate amount of the settlement, not only for parties that have tried to move their own putback litigation forward, but arguably for all parties.

Petition Contesting Bank of America Mortgage Settlement, July 5, 2011

The biggest challenge, in the court of public opinion as well as presumably before the judge, is the idea that this is not at all an arm’s length transaction, and that the trustee, Bank of New York, is effectively engaged in self-dealing, selling out the investors to save its own hide. To put it more simply, parties that are presented as representing the investors’ interests are actually working to advance the BofA cause.

Bank of America gave the Trustee, Bank of New York, a side letter than indemnifies it for all liability incurred in entering into this deal. That means if any investors are unhappy, the costs are borne by BofA (the party that benefits from this settlement) not Bank of New York, the party supposedly representing the investors.

Bank of America Settlement – BoNY Side Letter

As the lawsuit drily notes:

It is very unusual, to say the least, for a trustee that says it is representing the interests of the beneficiaries of a trust, to demand and obtain an indemnity from the very party that is adverse to that trust and its beneficiaries (in this case, the certificateholders). BNYM concedes in its petition that it was concerned about its liability for the way in which it was handling (or, more accurately, ignoring) the demands of its beneficiaries that it take legal action for their benefit against Countrywide and Bank of America.

But it goes further: the side letter also indemnifies the trustee broadly against liability in the pooling and servicing agreements, the contracts that govern these deals. Since trustees like Bank of New York provided multiple certifications that the trusts held the assets (and that would include observing the chain of title niceties) when lawsuits all over the country have established that that did NOT happen. In addition, a senior Countrywide employee in testimony in Kemp v. Countrywide said Countrywide had retained the notes (the borrower promissory note) when the trust was supposed to have them. Whoops!

So the trustees have a ton of liability the are eager to escape. And that means that the indemnification in the Bank of America side letter is tantamount to a very big bribe to Bank of NY to go along with this deal.

Now why would investors agree to that? After all, aren’t 22 investors along for this ride? Let’s query how independent they are.

We had thought that Blackrock, which was formerly 49% owned by Merrill, which was then absorbed by Bank of America, was independent when this deal was struck. The buyout by Blackrock of its final shares had been set on May 19 and was expected to close June 1.

Funny, the lawsuit now tells us that the disposition of the remaining interest didn’t close until July 1, two days after the settlement deal was inked. Awfully convenient timing, no?

Readers have pointed out the New York Fed is hardly an economically-minded investor (otherwise, it wouldn’t have hoovered up dreck assets to save undeserving banking behemoths). Fannie, another party to the deal, is in conservatorship and its primary objective is to prop up the housing market. Its minders in the Administration might deem throwing Bank of America a bone (more like a side of steak) to be good for Obama’s image with Wall Street (or conversely, that they don’t want to take the risk of opposing or merely sitting out the deal). Goldman (admittedly, Goldman Sachs Asset Management) might also deem it to be wise not to ask too many questions about a deal that could serve as a template for other deals that would get it off the hook. I’m not certain why Pimco would go along, but it is awfully (as in troublingly) close to the Fed.

The rationale for the other investors may simply be that they never intended to sue on putback issues, so any money looks like a freebie to them. But the flaw in that reasoning is the broad release. They are effectively trading a barely out of the money option for free.

Foreclosures are going at a snail’s pace due to all the “paperwork” problems, which really means the screwed up chain of title issues which make it at least costly and in many cases impossible for the trust to foreclose if the borrower challenges it. And as more borrowers are getting savvy and fighting if they can’t get a mod (and services are still not very keen to give mods, their recent PR efforts notwithstanding) loss severities (losses as a % of original value) are going to skyrocket. They are now around 50% for prime loans and over 75% for subprime. Higher loss severities are not reflected in current RMBS prices.

When the market wakes up and RMBS prices ratchet down, investors may decide to go after the parties responsible for this mess, if nothing else to force principal mods, which are cheaper than being stuck with loss severities on certain mortgages in excess of 100% (whIch I’ve seen happen on contested deals, legal costs can easily exceed the value of the house in liquidation).

Another reason investors may have been asleep at the switch is they may have been persuaded by the lawyer who is allegedly working for them, Kathy Patrick. Earth to base, her $85 million fee is being paid by Bank of America. She is working for the deal, and Bank of America was not interested in a deal unless it was plenty favorable to it.

As one structured credit attorney who is not working for investors on this or any other putback deal wrote me to say that Patrick should be disbarred for her conduct on this transaction. Even if she has obtained the waivers from the major participants regarding her conflicted role, he argued that it’s preposterous for her to claim she is representing the investors in 530 trusts when it is certain in most, perhaps all, the 22 investors she has signed up do not represent 51% of the interest.

That brings us to the second point, the questionable procedures involved. We’ll address this more briefly. The petition is from some investors who were pursuing putback claims on three of the trusts in this deal. Their interests were known. Not only had they demanded that the trustee, Bank of New York Mellon, put back the loans, but when ignored, they sued the trustee and that litigation is pending:

BNYM nevertheless made no effort to inform Walnut Place or the hundreds of investors in Countrywide trusts other than the 22 self-appointed investors that BNYM was secretly negotiating a deal with Countrywide and Bank of America, much less to solicit the views of those investors about what terms of settlement would be fair or whether they wished to be “represented” in those negotiations by the 22 self-appointed investors.

The petition also argues at some length that the Order to Show Cause filed by the parties to the settlement (Bank of America and the Bank of New York Mellon) does not provide a mechanism for certain trusts to be excluded from the deal and can only provide “written objections”. They note:

It is unreasonable to expect certificateholders to wait until the final approval hearing on November 17 before knowing what conditions they must satisfy to exclude their trusts from the proposed settlement and whether they have fulfilled those conditions. At the very least, certificateholders that object to the settlement must have sufficient notice that their request to be excluded has been denied so as to permit them to challenge the settlement in other ways.

This is legalese for “the non-participating investors are being railroaded.” I’m told by someone who has investors contacts that a lot of other investors in these trusts are decidedly Not Happy. And the reading of MBS Guy, who looked at randomly selected Countrywide pooling and servicing agreement (CWABS series 2006-10) supports that view:

The provisions on the trustee and certificates generally talk about affirmative actions. I don’t see anything that indicates the trustee can waive the rights of certificateholders who don’t agree to the provisions. Practically speaking, however, if a large portion of the certificate holders agree to the settlement, it would foreclose the possibility of any other lawsuit in all likelihood.

In section 8.13, Suits for Enforcement, the trustee shall act to enforce or protect the rights of the certificate holders upon the direction of 51% of the certificates. This is a higher threshold than the 25% required for certificate holders to initiate an action, as provided by section 10. 08.

Importantly, according to section 10.08, certificate holders suing the trust do not have the right or ability to

affect, disturb or prejudice the rights of the Holders of any other of the Certificates, or to obtain or seek to obtain priority over or preference to any other such Holder or to enforce any right under this Agreement, except in the manner herein provided and for the common benefit of all Certificateholders. For the protection and enforcement of the provisions of this Section 10.08, each and every Certificateholder and the Trustee shall be entitled to such relief as can be given either at law or in equity.

I interpret this to mean that the rights of the certificate holders who don’t agree to this settlement should not be adversely affected or waived if they don’t agree.

Finally, there is the question of whether the $8.5 billion is remotely adequate. Given that Bank of America had formerly resolved to fight this type of suit tooth and nail, and the investors had done nothing to develop litigation, the Bank clearly must regard this suit as a screaming bargain to have reversed itself so decisively. And the petition points out that the investors on the three trusts had spent hundred of thousands of dollars in investigation and had determined that there were substantial rep and warranty breaches in these deals, as high as 66%., or $242 billion across all the 530 trusts. The usual rule is the more you do to build a case, the more you are likely to obtain in a settlement. We’ve long been skeptical of rep and warranty suits because they cost so much to build, but the low settlement amount (even by our jaded standards) shows the willingness of the attorney to maximize the return on her time rather than the result for her clients.

This may simply seem to be a fight among what ought to be consenting adults, but letting the TBTF banks off the hook for liability, failing to reform securitization practices (the measures in this settlement are either cosmetic or affirmatively bad for homeowners), and dumping the damage on investors eliminates one of the biggest leverage points, the risk to the financial system, that can force the key actors (including complicit regulators) to come up with remedies. Allowing the banks to escape not only rewards their bad conduct, it will also assure a significant overshoot to the downside in this housing market correction that will hurt consumers and the economy generally.

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  1. David

    Out of curiosity, can an outsider file a complaint to the relevant state bar about this conflict of interest by
    Kathy Patrick ? I recall that there were people who complained to the Texas bar regarding the things done
    by former attorney general Alberto Gonzalez.

  2. Fractal

    Wait, isn’t that Linda Green’s forged signature on that BAC side letter? how much good will that do for BNY Mellon?

  3. Richard


    Nice article, particularly the list of conflicts of interest. One conflict left off the list is that the 22 investors have an incentive to settle. While these investors have a fiduciary duty to their clients to maximize the settlement, the institutional investors do not want to do anything that will aggravate Wall Street and make it hard for them to get in on the next deal.

    Remember, the institutional investors see themselves as portfolio managers. These are Not guys who sue people for being lied to.

    Until the institutional investors are sued for this fiduciary failure, they will be happy to short change their clients.


    1. steelhead23

      I agree. The true injured party of an institutional investor are the beneficiaries of that institution – such as pensioners, but I can hardly imagine how such a suit would be pursued. That is, not only the institution, but its counterparties would be very interested in quashing such suits. As pensioners, as a class, are not wealthy, a law firm would have to be almost suicidal to take such a case on on a contingent basis. In a nutshell, I would suggest that BAC made a very astute deal. While $8 Billion is a damn big number, it likely pales to insignificance when viewed against its potential liabilities were they in King Solomon’s court.

  4. David

    Sounds unusual. But suppose B of A got stuck for $240 billion or so. You can’t get blood out of a stone. And is B of A fully liable for debts incurred through Countrywide which is a separate legal entity?

  5. John S

    I believe, when this is all done, we will find that BofA owns 51% of every one of the MBS trusts in the settlement.

    The upper trances were in fact sold, the bottom trances I believe were retained by Countrywide. These are the first to fail trances, but that were essentially “free” to CHL.

    1. Yves Smith Post author

      Not correct. Countrywide said in SEC filings that it sold 96% of the loans it originated. No one retained the lower tranches. They went into CDOs (and that included the junior AAA tranche). They might have gotten stuck with them at the end of cycle, but that’s different than design.

      The originators used to retain the equity tranche, which was a mere 1% or so of these deals, but in later stages of the bubble, these were typically securitized into NIM (Net Interest Margin) bonds. There was a small group of hedge funds that was keen to buy them, That was because the equity tranche got the overcollateralization and the excess spread, so if the deal turned out OK, they’d get a nice hedge fund type return, and quickly too (in a year or so), so the principal in the NIM bonds would come back pretty quickly and they’d reload.

  6. watercarrier4diogenes

    minor correction. Title says $242, body says $424, or are they referring to two different things?

    1. Yves Smith Post author

      $242 billion is the asserted liability and that comes from the lawsuit itself. $424 billion is total original par value. $242 billion is purported to be the current value of bonds outstanding.

  7. Hugh

    It is pure kleptocracy. The looters run their cons and when they get called out on them, they have already pocketed their winnings and proceed to settle any complaints for pennies on the dollar.

    All the interconnectivity and conflicts of interest are merely indications of the distraction going on, that the ultimate bagholders in all this are going to be ordinary people, as they always are, not the bank, not the trustee, not the lawyers, not the Fed, not the regulators, not the politicians, and not the bond fund managers.

  8. CNN Breaking Wind

    Bank of America shares tumbled nearly 3% Wednesday after a small group of bond investors rejected the deal struck last week with larger investors who were also burned by fraudulent mortgage securities.

  9. Francois T

    This affair is heading for a Circuit Court of Appeals, no less. I can’t see those investors letting go their claims, nor can I imagine the “22” BNYM and BofA giving ground.

    It’ll be fascinating to see if the observation that “the higher the Court, the more it suck at law while ignoring justice” holds true.

    My bet is that it’ll hold: in the last two decades, federal court of appeals have amply demonstrated how tilted toward the Establishment and the Prevailing Order they can be. And let’s not get started about the Supine Court, shall we?

  10. Thomas Barton, JD

    Is it possible that this bank, the Bank of America, is in a profoundly weakened state not due to its exposure to this sphere of liablities but rather to unknown and unquantified exposure to the Eurozone .If it is in fact then a seemingly naked payoff to one of its closest corporate bretheren and the seeming gross misconduct of the attorney make perfect sense. The Spanish galleon is sinking and it only has a few chests of gold not the hull full of bullion that it has been claimed to be bearing.

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